What you need to know about liquidated and ascertained damages (LADs)

Quantum of Solace

Liquidated and ascertained damages (LADs or LDs) are a predetermined measure of damage agreed between parties to a construction contract before the contract is finalised.

LADs are mostly used to deal with culpable delay; however, they can be utilised in connection with the occurrence of any specified contract breaches.

LADs are applied as a set value over a set period; such as £1,000 per week. This means that (in the example of culpable delay), if the contractor overruns the contract completion date by a week (and is not entitled to an extension of time), the employer will be entitled to levy a contra charge of £1,000 against the contractor’s final account.

LADs can also be applied to sub-contracts, as well as main contracts; a fact that is sometimes overlooked. This process is not straightforward; however, as there are a number of potential problems that need to be overcome:

1. Simply passing down main contract LADs within sub-contracts usually fails to take proper account of every potential consequence of subcontractor delay (such as additional prolongation costs and disruption claims) or other specified breaches. Very careful thought must be given to the appropriate level of subcontract LADs;
2. How does the contractor deal with the possibility that it may be able to make LAD claims against multiple subcontractors, but it will face only a single LAD claim from its own employer? This opens up a potential risk of uncertainty and / or double recovery (which could leave the LADs open to be challenged as an unenforceable penalty).

In practical terms, the potential benefits of including LADs in subcontracts needs to be carefully weighed against the potential problems, as set out above. In certain circumstances, the inclusion of LADs will make sound commercial sense; whereas in others, it will be preferable to retain the main contractor’s right to claim general damages or to include a specific clause allowing recovery of loss and expense resulting directly from the relevant breach.

Benefits

There are a number of benefits to including LADs within contracts. These include:

Certainty – in the event that a specified breach occurs, both parties know the consequence; namely, LADs will be applied at the agreed value. This certainty benefits both parties, as it allows them to adequately plan for the consequences of delay (or other relevant breaches) and it also avoids complex, time consuming and costly disputes trying to ascertain the quantum of the injured party’s actual loss.

Limitation of Liability – LADs place a cap upon the contractor’s liability for its own breach. This means that liability for any specified breach will never be greater than the applicable, agreed LAD figure; regardless of the actual losses that may be incurred by the employer.

Saves Time and Expense – by avoiding the need for complex disputes over quantum for general damages, the parties can focus upon dealing with other issues; such as ensuring the accuracy of the construction programme and the length of any culpable delay to be applied to a particular contractor. In allowing the parties to focus their efforts on issues of liability rather than quantum, LADs encourage them to ensure that record keeping in respect of these issues is of a high and consistent standard.

The ability to focus on more limited issues helps the parties to avoid the risk of ‘drowning in paperwork’; which can often be a very real concern in connection with complicated contracts and disputes (particularly for smaller contractors).

It has also been confirmed by case law that a party has no duty to mitigate its actual loss when claiming LADs; therefore, an additional potential area of dispute is removed.

Strong Deterrent against Breach of Contract – A carefully imposed LAD clause can operate as a very strong deterrent against breach of contract. Where a party knows the exact financial consequence of not meeting its contractual obligations, this is usually a much more effective motivator than the often vague and nebulous concept of general damages liability for actual proven losses.

Beware of Penalties

Courts will not uphold penalty clauses against defaulting parties. In Law v Redditch Local Board [1892 1 QB 127 (CA), Lopex J said that:

“If the intention of the LD’s clause is to secure performance of the contract by the imposition of a fine or penalty, then the sum specified is a penalty.”

When assessing whether a clause amounts to a penalty or not, Courts tend to uphold LADs.

The test often cited to determine the difference between LADs and penalties is whether they amount to a genuine pre-estimate of loss. Whilst this test remains useful (particularly when considering simple LADs clauses), the relevant case law has moved on, meaning that the relevant test now applies somewhat different criteria (outlined in the case of Cavendish Square v El Makdessi and ParkingEye Ltd v Beavis [2015] UKSC 67).

The key consideration is that the relevant clause must impose an obligation upon the defaulting party that reflects the legitimate interests of the innocent party (to secure performance or an appropriate alternative to it) rather than simply seeking to punish the defaulter. In many straightforward damages cases, this legitimate interest will not extend beyond compensation for the breach; however, this is not necessarily the only legitimate interest the innocent party may have in performance, therefore each case must be considered on its own merits.

Time at Large

A party faced with a claim for LADs may be able to respond by arguing that time is ‘at large’ under the contract. If a delay event occurs that is the employer’s fault and the contract does not make adequate provision for dealing with it, the completion date under the contract will fall away and the contractor’s obligation will be altered to one in which works must be completed within a ‘reasonable time’.

The justification for allowing the contractual completion date to be replaced by a reasonable time obligation is that if the contractor were forced to complete by the original completion date (even though it had been delayed by the employer through no fault of its own), the employer would stand to benefit (by being able to impose LADs) from its own breach (its culpable delay). This is known as the ‘prevention principle’, which provides that no party can benefit from a failure of compliance (e.g. non-completion) where that party has actually prevented the compliance of the other party by its own actions (e.g. culpable delay).

For expert advice about LADs clauses and their incorporation into main contracts and / or subcontracts, contact our Construction Law partner, Michael Smyth at michael.smyth@orj.co.uk or by telephone to 01785 223440.